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Interpretation

The acid-test’ ratio is a rigorous measure of a firm’s ability to service short-term liabilities, The usefulness of the ratio lies in the fact that it is widely accepted as the best available test of the liquidity position of a firm. That the acid-test ratio is superior to the current ratio is evident. The current ratio of the hypothetical firm is 2 : 1 and can certainly be considered satisfactory. This interpretation of the liquidity position of the firm needs modification in the light of the quick ratio. Generally, an acid-test ratio of 1 : 1 is considered satisfactory as a firm can easily meet all current claims. In the case of the hypothetical firm the quick ratio (0.5: 1) is less than the standard/norm, the satisfactory current ratio notwithstanding. The interpretation that can be placed on the current ratio (2 : 1) can add-test (0.5 : 1) is that a large pan of the current assets of the firm is tied up in slow moving and unsaleable inventories and slow paying~ debts, the firm would find it difficult to pay its current liabilities, The acid-test ratio provides, in a sense, a check on the liquidity position of a firm as shown by its current ratio. The quick ratio is a more rigorous and penetrating test of the liquidity position of a firm. Yet, it is not a conclusive test. Both the current and quick ratios should he considered in relation to the industry average to infer whether the firm’s short-term financial position is satisfactory or not.

A variation of this ratio may be super-quick/cash ratio, This ratio is calculated by dividing the super-quick assets by the current liabilities of a firm. The super-quick current assets are cash and marketable securities. This ratio is the most rigorous and conservative test of a firm’s liquidity position. Further, it is suggested that it would be useful, for ‘the management. If the liquidity measure also takes into account reserve borrowing power as die firm’s real debt paying ability depends not only on cash resources available with it but also on its capacity to borrow from the market at short notice.

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